Greece is not Europe's Lehman: Spain would be. But it's avoidable

Yesterday's developments summarised: Merkel and Strauss-Kahn meet and no bailout is forthcoming. Strauss-Kahn tells German MPs that the final bill could come to E120bn, for Greece alone. The boss of the OECD calls the contagion "Ebola" and though this comes out at lunchtime, when Bloomberg wires it during the close of the London markets, they temporarily tank. An analyst from JP Morgan puts a E600bn price tag on an EU bailout of Portugal, Spain, Ireland and Greece. Nouriel Roubini re-emerges in doom mode warning that Greece is the tip of the iceberg. The whole thing gets a total of four minutes on Newsnight because of Gordon Brown's gaffe...

So where is it going next, and are the contagion fears overblown? First, from conversations with bond market participants the Greek story has changed and is no longer about whether a bailout will happen: once the word "haircut" entered the conversation, the markets were spooked. If the Greek bailout is so big that governments insist bondholders take a hit, to the tune of a 50% loss (or "haircut") on what they are owed, then it is time to lessen your exposure to south-European sovereign debt.

Fund managers are judged by their performance. Long-term asset managers, for example pension fund managers, are so heavily into sovereign debt that any debt write-offs on this scale are "career finishing events", says one source. They're used to thinking of 2% losses on sovereign debt as large. 50% means, well, sovereign debt does not exactly deserve the moniker "gilt edged" anymore.

Bond strategists have started to analyse what's happened in the past - with South Korea or GM - where the debt becomes junk, a restructuring happens and then the value of the bonds come back. It is not looking pretty - you rarely get your money back - hence the contagion.

The market in Greek debt, says Graham Turner of GFC Economics, is effectively broken. If Portugal goes the same way then whatever template the EU creates for Greece will have to be applied to Portugal, then Ireland and Spain come under pressure.

Since many banks also hold south-European debt and use it as collateral to borrow from the European Central Bank, this could spread the contagion to the banking system. It already looks likely the ECB will start to swap its good money for the banks' junk, just as the Bank of England did.

OK - that's the "markets" part of the contagion story. Now here's the political economy: if you read the S&P, Fitch, Moody's etc notes about the so-called "PIGS" countries, one theme comes back again and again: total lack of realism by governments about the scale of cuts and tax rises needed, total over-optimism about the growth they can expect.

S&P for example predicts 0.7% annual growth for Spain out to 2016. The Spanish government is talking about >2%.

So what is emerging is a disconnect that does remind you of the build up to the Lehman collapse.

You get the discovery of dodgy data (incoming Pasok government finds books in much worse state than imagined); then you get denial; then you get the crunch where the authorities say to an institution's peers "guys you gotta bail them out or you go down with them".

In Lehman's case we know what happened. The banks refused to bail out Lehman and the US government let it fail. With Greece, it is by no means certain that the bailout will happen. As its estimated cost rockets, and the political consequences become clear, you are already getting an incremental version of what happened with Lehman - that is the EU governments passing the buck to the IMF, just as Goldman, Citi and JP Morgan passed the buck to Hank Paulson.

But even if Greece goes bust it can be contained. Even if it costs, as Strauss-Kahn says, 120bn Euros, the IMF could do that. It could call on the world to help, not just the kleinburgerlich electors Nordrhein-Westfalia.

But let's get to the root of why that might not be enough.

Lehman sparked a systemic liquidity crisis because Wall Street's bosses looked at each other and said, "you know what, I don't trust you: I only trust myself". Even as the big bosses frantically ordered their traders to go on trading with their rivals, market logic forced them to stop trading and stab each other in the back. It was a crisis, in the end, of credibility.

As the financial crisis has become a fiscal crisis, it is now the credibility of states that is in question. The credibility of their bailout pledges and of their deficit reduction plans.

If Germany and France have to bail out Greece, the first question is - will their electorates buy it? If not, then the EU-managed bailout solution is not credible.

But there is a much bigger problem of credibility among the stricken countries. There is no evidence whatsoever that they can impose the necessary austerity on their populations to meet the conditions of the bailouts. With Ireland, worse, there is a dawning realisation that its tough deficit reduction plan, lauded as a model for others, may not be enough.

What has to be stressed here is that we are in a totally unprecedented situation. With all debt defaults in the past there has been a strong creditor group of countries that took control of the process; even to the extent of manipulating the politics of the stricken countries, as the United States did to Latin America in the 1980s.

But now it is the developed world that is in danger of going bust. For the past two years governments have improvised a rough-and-ready Keynesianism. But that response is now in crisis.

Keynes himself never advocated strategic use of budget deficits: he advocated temporary fiscal expansion (tax cuts and spending increases) to boost growth and soak up excess labour, with deficits as the price. Keynes' chosen methods were monetary: manipulate the currency, print money.

In the Depression, those who ran up deficits never went much higher than 5% of GDP. And remember this was in an era of closed markets - we're now in an era of floating exchange rates and open capital markets where running a giant permanent deficit is only really an option for self-contained markets like Japan, or a dominant superpower like America, and then comes with huge eventual downsides.

We will never know what would have happened if the Brits had simply nationalised Northern Rock on day one, if Paulson had let Bear Stearns go bust and bailed out Lehman instead. But there is every chance that if the EU and IMF handle the Greek bailout deftly, the contagion stops at Greece. If they do so they will demonstrate the competence of institutions that badly need to demonstrate it. They will restore credibility.

But if the Greek bailout is delayed so long that it infects Portugal, then Spain drifts into the crosshairs. I cannot see the northern Europe finding the equivalent of 8% of GDP for Spain.

Just as the Germans are finding reasons to dislike the Greek lifestyle (except for the one month a year when they choose to live it), northern Europe will surely find a reason to dislike Spain's. "They've lived an unrealistic lifestyle" will be the refrain - even if that lifestyle involves glorious football and Almodovar-style high jinks, rather than kleftiko and retsina.

Spain, like Lehman, could be too big to bail, say people in the markets.

And here is the unspoken politico-economic truth about this crisis: America has transferred the pain of the crisis from banks to taxpayers, but it has not imposed austerity. The US is still in the middle of its fiscal stimulus. Ditto China. That leaves Europe, where the logic of saving the banks using taxpayers' money means that the European population pays the price.

It will be noted that each of the stricken countries is a "young democracy": (Greece overthrew the junta in 1974; Portugal underwent a revolution in 1974; Spain saw armed officers attempt to storm its parliament as late as 1981).

In retrospect we can see how the wounds of left-right battles in the 1970s were finally healed by the rapid, speculative growth that came with Euro-entry. The Balkan wars show us how easy it is to reopen old wounds.

For these reasons, imposing the cost of the banking crisis on the population of Europe is going to be hard. The north-European electorates will be disinclined to vote for it; we've seen, with the IFS report, how disinclined British politicians are to tell us the truth about the scale of the coming cuts. And the south-European population - whose iconic type is no longer the anarcho-syndicalist dock worker but the unemployed trendy graduate - will not very likely put up with it.

There are ways out: break up the Eurozone; hand the problem to the IMF, setting back for a generation the EU's claim to fiscal authority. You could inflate the entire problem away, but unless you cut Europe adrift from the international markets it would provoke further mayhem. You could impose more of the cost of the banking crisis on the bankers themselves - through aggressive nationalisation and breakup.

But in the end, the price you pay for a system wide financial crisis comes down to this: either your own population pays for it, or you pass off the cost to somebody else.

Does this play into the British debate on fiscal policy? You bet it does. Market participants know that if the whole of south Europe catches the contagion then Britain's immune system is already compromised. Will it provoke a sudden outburst of clarity about the unspecified cuts they plan (£52bn for the Conservatives, £44bn for Labour, £34bn for the Libdems) in tonight's debate? We'll let you know.

* Watch it live on the BBC and then tune to Newsnight on BBC TWO for instant analysis

Comment number 1.

Another bang on job Paul------------------------------------Hopefully people will see that Birmingham isn't such a dump from the pre-debate shots and talk. Birmingham University is an attractive place - during the eighties I would visit the Barber Institute (which is with-in Birmingham Uni) on a regular basis to study art. I can recommend it for any of the media who maybe have half an hour or so to spare - spy a great Edgar Degas or just walk around a beautiful building in quiet and get away from all the hype and sovereign debt crisis.

Comment number 2.

Excellent piece Paul...Grand Canyon in full view...is that the Colorado River twinkling at the bottom or the lights of prosperity going out all over Europe?[we shall not see them again in our time] (excuse the distorted quote from Sir Edward Grey)

Comment number 3.

this could be the turning point...and it started in Greece where most good things start like civilisation, democracy etc., we never get to vote in the EU like er, the constitution !!! They do not publish accounts, imagine anyone else trying that one for 15 years!!! It is the gravytrain to beat all gravytrains. It is right wing centralist with no accountability and should be disbanded...maybe the Greeks have found a novel way of starting that process...hopefully....

Comment number 7.

Not that you need praise from me, but well done Paul, excellent piece, clear precise and unspun with a common logical thread throughout and a bit of creativity thrown in also.

Right on the money and contained all the things I look for when checking calculations, attempts at misdirection and manipulation jump out at me in calcs as they do in journalism and politics.

Glad you are around to keep the likes of me sane, because to be sure, in times not too far away the world will need engineers like me to remain sane and be on our game to help clear up the mess the lawyers, bankers, politicians and estate agents types have left for us.

I am trying, I really am, but I am sruggling to see (based on past performance) how the current generation of european leaders are morally and technically equiped and brave enough to do the right thing here to 'avoid it'.

They may manage to contain it for alittle while longer but i just dont see anybody grasping and confronting the underlying situation, formulating a viable (least damaging) solution and communicating that in an unleveraged way and with vision to the people.

Comment number 8.

Good piece, Paul. In a way, sovereign debt contagions are potentially more dangerous than dealing with bank contagions. In dealing with banks the politicians had regard to millions of innocent voters and their deposits in need of protection. Easier to make the case for intervention. However, if the source is a feckless sovereign country the reason to act becomes blurred by nationalistic and cultural objections without the wider universal goal of protecting all savers.The need to protect the "eurozone" or the euro-ideal is not a universal goal shared by all global politicians. Unless savings are universally threatened, as they were in 2008, the dynamics are different now.I agree it could be more dangerous, therefore. More room for self interested behaviour.

Comment number 10.

Another fine blog of a fine mess we have got into. Keynes to be left to sleep in his tomb? Is the answer taxes rises and benefits cuts and two recessions for the price of one? National debt too high to spend to grow?An answer is a western world wealth tax to pay off social debt. Reduce billionaires to multi-millionaires and multimillionaires to millionaires. Withdraw from all military conflicts, tax carbon not increase VAT. Create jobs in public services for those 8 million not working but receiving benefits i.e. offer pay at benefits +. Alternatively persuade PIIGS to leave Euro and sort themselves out (joke)

Comment number 13.

Btw, I don't think it is avoidable now - I think we are on a course for economic disaster in the much the same way that the Titanic had the entire Atlantic in which to sail but still could not avoid the iceberg.

Life is so much easier when you accept your fate, open a beer and decide to sit back and enjoy the ride - no matter where it takes you.

Comment number 14.

You say Spain would be Europe's Lehman, but so would the UK, I fear. Britain might even be the world's Lehman, given we're a global financial centre.

I see the first post is someone making a plea to take a second look at Birmingham! To my knowledge people have been making the same plea for the last 30 years; I can't say visually I've found the city has ever improved much, but the people are always friendly.

Comment number 15.

Why is there a sovereign debt problem?Essentially because government tax revenue has been hit by the recession.

Why has there been a recession?Because business profit rates have fallen.

Why have profit rates fallen?Partly due to financial assets falling in value, e.g. the stockmarket collapse of 2008/09, which in turn is related to the hoarding of capital - out of shares & into gold.This slowing of the turnover of capital also causes profit rates to fall.

Profit is also a function of the rate of surplus value (essentially the difference between the value created in the labour process & the amount paid for the labour power) & the organic composition of capital (more difficult to explain, but it is the ratio of constant capital [machines, raw materials, etc] to variable capital [wages]).

But arguably the main cause of the fall in profits (admittedly to be proved), is the decline in 'free' inputs into the circuit of capital.This is the looting that Rosa Luxemburg refered to.Chinese peasant labour is a 'free' input in the sense that capitalism hasn't paid for the 'production' of peasant labour, whereas in a non-peasant economy, the living wage has to be enough for labour to reproduce itself.Looting also extends to the grabbing of resources, such as oil.

The fall in the underlying profit rate has arguably been happening since the late 1960's & has been 'hidden' by the growth in financial assets, themselves fuelled by the printing of US dollars (no longer tied to gold).

Hence the problem originates in capitalist production & has been transformed into a credit crunch, recession & sovereign debt crisis.

For profitability to be restored vast amounts of capital need to be devalued/destroyed - far more than the amounts so far.

The capitalist system is bust.The workers cannot afford to keep the rich in the life they have been accustomed to.

Comment number 16.

However, there is still a lot of "Bailout baloney" going round. Undoubtedly there is a heck of a lot of debt floating around (and this includes almost every developed nation - whether, Greece, Ireland, the UK or the US).

The debt is just being used to delude ourselves into living well beyond our means. When will we in the West get our thick heads around the fact that our "wages" are just ridiculusly high? Globalisation, technology and good old oil has made it very easy for other countries to do the same things in the way we do them. The end result, genuine factor price equalisation. Alas, not by bring up the poor to our standards, but by ours reducing substantially.

The writing was on the wall more than 30 years ago, but we chose the path of economic / financial gerrymandering.

As someone once said on this blog, all this current activity to "solve" the crisis is like farting at thunder. The damage has already been done, and to such an extent that there is no true way to stop it. On the one hand we could sit back and drink beer (#13), or we can plan the wind down gently, as it really won't be a pleasant sideshow to watch.

Comment number 17.

Comment number 18.

"The workers cannot afford to keep the rich in the life they have been accustomed to."

indeed. But its doubtful the rich will easily let go of their ill-gotten gains, even if it is transparently in their own long-term best interests.

the people who live in mansions, and holiday on their luxury yachts would prefer to see British Troops firing on the British People, rather than pay their share of taxes, and get the UK out of the hole **THEY** have created with their bottomless greed.

Comment number 19.

Sorry, but working for £65 a week is not only illegal it is immoral corporate welfare of the very worst kind.

For too long the british public have believed the nonsense about th eunemployed being uneducated, lazy.... My niece couldn't get a job in this country - she had a PhD from a Russel Group uni in molecular biolgy so she was forced to leave this country. She's now working in Africa with quite a few gBrits who couldn't find work in the UK - yet African employers are paying them well and want more just like them. Yet here, we assume they are lazy, idle, and thick. We should be ashamed for swalling the nonsense before we wake up to see we have forced people to live in tents. I'm a cancer scientist and have known a lot of talent in my field to have problems finding any kind of work in the UK. I've known lawyers, computer programmers, teachers ex-armed services, documentary makers all struggle to find work month after month.

I've been unemployed in my life too. Employers have told me I'm too old (at age 30!) and a common one is this: you are over-qualified! Strangely those same employers wouldnt find me over-qualified if the government sent me to work for them essentially for free., would they.

My advice to anyone told to work for benefits is to demand a similar charitable spirit from all retailers, service providers and in particular those who insist working for benefits is good for you, that they themselves should do as they ask you. And that includes all those who receive any kind of benefit, child benefit, child tax credit, free prescriptions, free schools (hardly anyone on this planet gets free education so what makes the Brits think they should be any different? Work for nothing, educate your own kids so if you can't pay the fees don't have them. stop expecting society to take care of your family and personal choices, take care of your own parents and don't ask me to contribute to their care because they are your parents and your responsibility so stop being so lazy! Oh, and all benefits received over your lifetime to be paid back! There you go. Is that what you really, really believe? It is where that slippery slope will take you. Picking on the unfortunate is always philosophically dangerous.

The recession has woken up a few folk to the reality of life rather than the journalistic spin. A second dip just might make more people wake up. A lot of people suffered in the '80s and seem to have magically forgotten just how awful unemployment was, magically managed to convince themselves it was different then, that they aren't lazy and that is why they have a job.

People have been voting for capitalism since the 80s in this country but they are unwilling to accept the responsibility that comes with that choice - people have deliberately choosen a system that impoverishes people, leaves millions unemployed, yet there are too many who are willing to kick their victims, blame the victims the electorate created. If you want to have capitalsim, then accept their will be those who will not find work, accept that they need homes, clothes, food and heating. And pay for it. Like a responsible adult who is big enough to understand that those unemployed, those sacrificed, are making your comfortable lifestyle possible.

To look to those victims as a source of free labour is to be frank, disgusting.

Comment number 20.

but i would not use the vague term "capitalism", i would use the more accurate and hard-nosed "exploitation". We live in an exploitative system, and in such a structure many people are crushed.

we can blame them personally for that, or we can help them - and also help their children to live better lives through giving the quality housing, sustenance and education their parents cannot, for whatever reasons. How we respond to that question determines what kind of a person we are.

Comment number 22.

Having supported and sustained Europe with the Marshall Plan the Americans it now appears intent on destroying it. The EURO is being targeted by the same banksters who gave us the credit crunch. It could not remain insofar as Iran was trading oil in Euros. The IMF having been allowed in through the front door will collapse Greece just as it did in Argentina. The media will drop Greece from its reports once the real resistance to the measures start. Having presented the bailouts as the saviours of banks they are now presenting the IMF as the saviour of national defaults. Nothing of the sort. For the nations of Europe to survive they have to go back to their national currencies.

Comment number 24.

Failure to support an informed public that can act knowingly and sensibly.

Failure to acknowledge public concerns, for instance the flow-on effects of immigration across jobs, housing and economy (NB Spain - v high immigration, several amnesties, 20% unemployment)

Failure to identify and name ideological frameworks in action, instead being dragged lazily along with the day's 'news', usually some dopey politician's comments, like 'Lord' Mandelson.

Failure to identify the non-stop neoliberal privatising/liberalising agenda which heads not only towards financial services do-as-you-like but towards transnational corporation takeover of the world, with the result that people are not tooled up to act against it.

Failure to treat with respect ordinary people who can see the problems, and the necessary action for solutions, instead waiting for head-on clashes, violence (great footage!) and the short of shock doctrine which will mean a big step forward in that corporate takeover, plus fascism - against own people, not the Socialist Worker version of migrant 'racism'.

All because you and your ilk have failed to provide the proper infomation in fact failed on what you are paid to do.

Comment number 25.

Assuming that the three leading parties actually do have a cunning plan for the missing cuts and savings identified by the IFS, there's the small matter of who pays should the cost of servicing sovereign debt go up - as a result of rating agencies downgrading our debt.

Just how high would an incoming Government be prepared to tax its electorate? Brown has been pretty creative with his stealth taxes, but there comes a point at which the people realise they are handing over more of their income (and any retained wealth) to fill a gaping hole left over from "rescuing" the banks and subsequent growth in the economy failing to meet projections.

(Funny that, because low economic growth is the likely outcome of taking "money out of the economy" in further taxes, rather than leaving it with individuals and businesses best able to generate growth. That's why Brown's repeated attacks over his NI hike is so topsy-turvy and shows his complete ignorance of a wider economy outside a grasping and nannying State.)

Should a Government - of any colour - find itself in the same position as Greece, what would it do? Eighty-percent taxes, anyone? (Just be thankful you get to keep twenty percent, though you'll still pay duties and VAT on what you spend). Or do you prefer a bail-out by the IMF with political strings attached?

The trouble is, I don't think any of us can actually relate to the size of the numbers involved.

Comment number 26.

"(Funny that, because low economic growth is the likely outcome of taking "money out of the economy" in further taxes, rather than leaving it with individuals and businesses best able to generate growth. That's why Brown's repeated attacks over his NI hike is so topsy-turvy and shows his complete ignorance of a wider economy outside a grasping and nannying State.)"

actually, most non-corporate economists regard that as propagandic bunk. In actual fact, Govt spending can *boost* an economy, and can place resources into growth areas, rather than allowing corrupt and controlled markets to determine the allocation of resources. And hugely, on top of that if the taxed money is being taken from tax-avoiding multi-nats and tax-haven-bound wealth, then growth can only be increased by taxes and targeted spending/investments.

through tax-avoidance murdoch has managed to build an immense personal media empire and vast fortune - making the b*st*rd pay some taxes on what he *removes* from our economy to his multi-national empire can ONLY be good for the UK.

in fact, as Chomsky amongst many others have pointed out, *every* economy that has experienced rapid growth across the board has achieved it by a combination of high taxes, and strong Govt intervention. Scandinavia has the highest taxes in Europe (i think), - would you argue that their citizens have been disadvantaged by this? Do they have an economy in massive crisis? Or do they have balanced economies?

spent right, taxation CAN be an enormous force for economic growth. Where it goes wrong is when the politicians and the very rich are in complete cahoots. See current UK and US for a good example of that.

"Should a Government - of any colour - find itself in the same position as Greece, what would it do? Eighty-percent taxes, anyone? (Just be thankful you get to keep twenty percent, though you'll still pay duties and VAT on what you spend). Or do you prefer a bail-out by the IMF with political strings attached?"

greece has two problems:

1. people and companies not paying taxes. One easy solution to this is to copy the Swedish model, where ALL tax receipts are placed in the public domain, so the People can check themselves what is being paid in. One of the best systems to cut massive large-scale tax-avoidance.

2. a Blairite/Thatcherite Govt that deliberately created a credit-boom, hid the scale of the problems, and enriched the wealthy. They are now in tremendous 'debt' to French and German banks, who were quite happy to flood Greece with cheap debt that brought back enormous returns on the usurious credit card terms. Sound familiar?

in the US, the 'sub-prime' mortgages were deliberately sold to home-owner wannabes, *knowing* they would eventually default, and the bank would not only end up with the repayments to date (often higher than rents), but could then seize the property come the inevitable default. This was part of the "deregulation" of the Financial Sector - before this such loans would have been negated, because the banks had a requirement to lend responsibly. That was removed, and people were deliberately targeted for loans they could not possibly pay back. In some parts of America, the local Law Enforcement are refusing to evict such people from their homes, and telling the Banks to go ...do something rude to themselves.

food for thought in the European Crisis?

#24:

and they would have lost their jobs for "scaremongering". It is all obvious to us NOW, (or to some of us), but there are innate limits to what Journalists can say and explain. BUT, if we had had a truly independent media, instead of a highly concentrated one, then at least in some part of it discussions such as those could have been started. But when Murdoch owns vast swathes of our national Media, and the rest is in disgracefully few hands (and all uber-wealthy), then is it *really* a huge shock that we were not informed that the current economic model (that was making them *even MORE wealthy!*) was - god i hate this over-abused word - "toxic"?

we should be extremely grateful to NN, especially paul mason, who HAVE pushed the boat out in terms of trying to warn us of what is REALLY happening.

yes, they could have been "edgier" - but then we would have lost them altogether. Its a balancing game, and perhaps *now* we are ready to hear the in-depth studies. It takes a long time to educate a population in solid economics before they can even start to understand the necessary discussions.

Comment number 27.

Paul - a fantastic piece BUT none of this ever makes it into mainstream political discussion or the main news programmes for that matter. What I'm not hearing from any of the politician's is a believable plan as to how we get out of this. Living in Scotland, one thing that is absolutely clear from all of this is that there is no way the SNP will be succesful. Can you imagine what would happen to sterling if the UK did not have access to all of the North sea oil and gas reserves. They may be depleting but they are on of the few things which the UK economy has got going for it.

About this blog

I'm Paul Mason, Newsnight’s economics editor, a job that takes me from Kenyan shanty towns to Russian hedge funds and Chinese factories. My blog is called Idle Scrawl. It veers wildly across the subject: from house prices, to global poverty; from deconstructing glib terminology to devastating critiques of the England football management. It is occasionally meant to be funny. Follow me on Twitter

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